If you’re one of the millions of Americans who have declared bankruptcy, financial recovery can seem like a pipe dream. But don’t give up. According to a study by the Consumer Financial Protection Bureau, people’s credit scores increased steadily after filing for bankruptcy. While any credit improvement is good news, is it enough to offer a chance at homeownership? Here’s what you need to know about buying a house after bankruptcy.
5 Steps to Buying a House After Bankruptcy
The good news is that you can still buy a home after bankruptcy. However, your journey may require a bit more effort, organization, and time than the average prospective homeowner. You’ll need to wait until a judge discharges your bankruptcy before you can get a loan, but beyond that it largely depends on how quickly you can get your finances in order.
Bankruptcy isn’t something anyone wants, but for people in dire financial trouble, it can be the only way to wipe out liabilities and get a fresh start. Bankruptcy can reduce financial stress, letting you focus on making positive financial decisions for your future. If you’re ready to move forward and make your dream of owning a home a reality, start working on these strategies today.
Note: Bankruptcy is a complicated legal matter. Please consult with a bankruptcy lawyer about your financial options before and after taking the step to file for bankruptcy.
1. Reorganize Your Finances
Once some of your debts are discharged in bankruptcy, you’ll be on the road to recovery. But don’t rush out to get a home just yet—wait for the dust to settle and get your finances in order.
Examine Your Debts and Credit Report
Take stock of where you are financially now that a few of your debts have been discharged. Next, get a copy of your credit report. If you have a copy of your report prior to filing for bankruptcy, use it to create a before-and-after picture of your finances. Make it a regular practice to review your credit so you can proactively watch for any mistakes and get them corrected. It’s also encouraging to see the progress you’re making over time.
Sign up for ExtraCredit to see your credit reports and 28 FICO scores from all three credit bureaus.
Put a Budget Together
Take control of your monthly household budget, paying every one of your bills on time, every time. Figure out your monthly income and expenses, so you know what you have room for—and what you don’t. Anticipate upcoming annual costs, like taxes or car registration, and put money aside so that you aren’t scrambling to scrape up the funds when these costs are due.
Consider a Credit Card
You can also start building your credit by using a credit card to pay some of your monthly bills. If you choose to do this, make sure you use the credit card like cash and pay it off every month. If you keep a close eye on your budget, pay all bills on time and monitor your credit report, you’ll start to see positive change that will get you closer to buying a house.
2. Grow Your Savings
If you’re interested in buying a house after bankruptcy, building up your savings is one of the most important things you can do. Now that you’ve refamiliarized yourself with your finances, it’s time to start saving.
Figure Out How Much You Can Save
One of the positive side effects of bankruptcy is that you’ll have the breathing room to start putting away a little bit of money every paycheck. And it doesn’t matter how small that amount is. It’s helpful to get into the habit of saving—even if you can spare only $5 every two weeks. Of course, the more money you can save, the better, but start saving no matter how much you can contribute.
An easy way to develop the habit of saving—and putting money towards a down payment—is to use a “forced savings” method. With this method, the money is put into savings before you even see it. The most common technique is to schedule an automatic deduction from your paycheck or checking account that transfers directly into a savings account.
Round-up apps are another easy way to save. They work by siphoning away small amounts here and there as you purchase daily necessities. You might not notice the difference between a $1.75 purchase and a $2.00 purchase, but over time you’ll appreciate the increase in your savings account.
Set an Objective
After you determine how much you can squirrel away each month, set a goal amount for your future home’s down payment. It’s recommended to put down 20% of the overall purchase price when you buy a new home. Although you can get some home loans with a smaller down payment, 20% saves you money on mortgage insurance and your monthly payment. It also gives you some instant equity in your new investment.
3. Make a Plan
There’s more to homeownership than signing on the dotted line and paying the mortgage every month. For example, as the homeowner, you’re responsible for any surprises that come up, which can be anything from a clogged drain to a new roof. Extra expenses like these are part of the homeownership package.
If you’re intimidated and worried that it might be too hard to buy a house after bankruptcy, just take it slow. The following suggestions will help you look at each piece of the puzzle without becoming overwhelmed.
Calculate What You Can Afford
In addition to saving up for a down payment, you should adjust your monthly spending to account for the overall cost of maintaining a home. Conventional wisdom is that you shouldn’t spend more than 30% of your income on housing expenses—including the mortgage payment. Before you set your heart on that darling Craftsman house, use this online calculator to find out exactly how much home you can afford.
Schedule an Inspection
When you’re shopping for a home, make sure you get a thorough appraisal and home inspection to help identify any potential problems that’ll need to be fixed within the first few years. If you don’t think you’d be able to afford those repairs, consider moving on to a different house. You don’t want to fall into credit card debt because of a surprise furnace replacement.
Consider Additional Costs and Factors
On top of significant home repairs, you should also prepare for regular maintenance, such as landscaping, pest control, and snow removal. Depending on your location, you may also need extra insurance for floods or earthquakes.
4. Organize Your Financial Documentation
Because you went through a bankruptcy, you know what it’s like to compile months—or even years—of pay stubs, account statements, tax returns, lists of assets, and other financial documentation. While buying a house after bankruptcy isn’t as rigorous as going through the legal process of reorganizing your debts, many of the same records are required for mortgage applications.
If you know you want to buy a home, you should start keeping meticulous financial records right now. Having organized financial records shows that you are sensitive to the details. If you have a finger on the pulse of your finances, you’ll know what your budget is, what your net worth is, and when you are creditworthy for a home.
Unfortunately, even in an electronic world, paper is still king when it comes to mortgage approval. You should keep both electronic and paper records. Have a copy of your bankruptcy petition ready, and add it to your credit report and bankruptcy discharge documentation.
An easy way to get your financial documents organized is to split them into different categories.
- Bank, credit card, and loan statements
- Investments—such as savings bonds, retirement accounts, and stocks
- Tax records
- Insurance documents
- Legal documents—like your bankruptcy petition and marriage or divorce records
- Employment records—including pay stubs
- Medical bills—especially if you’ve had large medical expenses
As you get closer to making a home purchase, find out in advance what documents the lender requires and make sure you have everything in place. A missing paper can delay closing on the loan and cost you extra money.
5. Shop Around for Mortgages
Buying a house is one of the biggest purchases you’ll ever make, so it pays to compare lenders when you’re ready to take the plunge. Many people overlook shopping for the best mortgage because it’s more fun to hunt for your dream house. Don’t make that mistake.
There’s more to the cost of a mortgage than the interest rate. You need to look at the whole picture to make sure you’re getting the best deal for your financial situation. If you’re coming off a recent bankruptcy, you should expect a higher interest rate right out of the gate.
Determine Which Loan Type You Need
Consider what type of loan is best for you. Conventional loans are offered by private lenders like mortgage companies, credit unions, and commercial banks. These loans tend to have more rigid criteria for approval but include more flexibility after the loan is secured. Government loans are also available.
The best-known government loan is the FHA loan, which is backed by the Federal Housing Administration. These loans usually have more flexible income and down payment requirements. However, FHA loans often restrict your ability to rent out or flip the property because these loans are intended for first-time or low-income homebuyers who are expected to make the house their primary residence.
While there are various loans, credit lines such as home equity credit, and programs, it may very well take some time to figure out what would work best for you. Is this your first time being a homeowner? Have you owned property before? Do you currently own another home? What about the past? Did you pay for everything on time? There is a lot to think about when it comes to this.
Know Your Interest Rate Options
When it comes to the nature of financing, you can get either a fixed-rate or an adjustable-rate mortgage. With a fixed rate, you are locked into the interest rate available at the time you sign your loan documents. This lets you have a stable mortgage payment, but you have to refinance if you ever want a lower rate. Adjustable-rate mortgages rise and fall with the market. This unpredictability means you could end up with a much larger monthly payment than you started with.
Don’t Forget About Additional Fees and Expenses
Fees for appraisals, inspections, title processing, and escrow needs can pile up fast. These fees can either be added to your up-front expenses or rolled into your loan. If combined with your loan, these costs will impact your monthly payment and the total interest you pay over the lifetime of the loan.
Because you’re getting a mortgage after bankruptcy, make sure the terms and extra fees make sense for your future goals. You’ve worked hard to rebuild your credit so you can buy a home. You don’t want to end up drowning under an interest rate or heap of fees that you can’t comfortably afford. An online mortgage calculator can help you research the impact of your location, credit rating, and type and length of loan on your interest rate and estimated monthly payments.
Homeownership After Bankruptcy
There is life—and homeownership—after bankruptcy. You’ve been given a chance to build a new financial future. Start with a clear understanding of where your credit stands. Then use the five steps listed above to help you buy your dream house.
DISCLAIMER. The information provided in this article does not, and is not intended to be, legal, financial or credit advice; instead, it is for general informational purposes only.